Don’t Let a House Ruin Your Retirement

March 27, 2017

For many people, homeownership is a major life goal, and they spend years saving to purchase their first home. But should owning a home come at the expense of other financial goals, like saving for retirement?

The answer is no. But a January 2017 Bankrate survey found that, in fact, more than one in three mortgages has a major impact on the borrower’s ability to save. And that may mean they spent too much on their house and their mortgage payments are too high.

If the 2008 financial crisis taught us anything, it’s that a home should not be viewed solely as an investment that will always appreciate in value. Nor should it be regarded as a retirement asset. A home is an illiquid asset that you live in, and like any other investment, it can increase and decrease in value. And even if it does appreciate in value, you can only realize that gain if you sell it at the right time for the right price.

So, if you are in the market for a home, here are some guidelines to follow as you navigate the homebuying process to guard against your home being a barrier between you and a comfortable retirement.

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While there are many financial considerations when buying a home, one major aspect is how much money you contribute up front to the purchase price. Ideally, a down payment of at least 20% allows you to avoid mortgage insurance and can lower your monthly bill. However, regardless of how much you put down on the home, you should not deplete all your liquid assets. You should still have a cash emergency fund of at least six months’ living expenses in place. That may sound like a tall order — and it is. But before you get locked into a home, you should be prepared for unexpected expenses.

Next, you’ll need to think about how much debt you can afford to take on. Debt is often necessary to achieve goals such as owning a home. But how much you borrow should always be considered in relationship to your income. Of course, everyone’s financial situation is different, but there are some industry standards that financial experts use to evaluate an individual’s debt-to-income ratio.

Two sound benchmarks to adhere to are the 28% rule and the 36% rule. These ratios are used to gauge borrowers’ ability to service their debts along with other financial obligations — like still being able to save each month.

Because monthly housing costs are usually the largest monthly bills for many people, it’s a good idea to make sure you don’t overspend in this area. To determine how much you’re spending — or plan to spend — divide your monthly housing costs (including principal, interest, taxes, and insurance or rent) by your monthly gross pay. This number should be no more than 28%.

Next, you’ll want to assess your total household debt level. This includes all housing debt plus other bills like loans and credit cards. To determine your debt-to-income ratio on a monthly basis, divide your total monthly debt payments by your monthly gross pay. The total sum of all your debts should be no more than 36% of your gross income.

Ultimately, while the 28% and 36% rules are general barometers, the more income you spend servicing debt, the less financially secure you’ll be and the less money you will have to put toward other goals.

While many people still strive to own a home thinking it will provide a sense of security and a chance to build wealth, it shouldn’t come at the expense of other long-term financial goals. The costs that come with owning a home are usually more than people originally plan for, and with so many competing financial obligations, it can be difficult to find enough money left over each month to fund your retirement and savings accounts. So while there is no foolproof way to prevent every scenario, using these ratios can hopefully help you avoid buying too much house and jeopardizing your retirement.